June 13, 2008 / 6:37 AM / 11 years ago

Inflation hits 7-yr high, RBI may move again

NEW DELHI (Reuters) - Indian inflation raced to its highest in seven years at the end of May and could top 10 percent this month as higher fuel prices feed in, stoking speculation of more central bank tightening after this week’s surprise rate hike.

A worker fills a car with fuel at a petrol station in New Delhi June 4, 2008. REUTERS/B Mathur

Wholesale price inflation, India’s most widely watched measure, rose 8.75 percent in the 12 months to May 31, well above expectations, data released on Friday showed.

The Reserve Bank of India (RBI) on Wednesday unexpectedly raised its key lending rate by 25 basis points to 8.0 percent to contain inflation expectations, but left all other rates unchanged.

It was the first hike in the repo rate in more than a year, but with the impact of costlier petrol and diesel yet to be felt, analysts said more could be around the corner.

“The number is a surprise given the fuel price hike is yet to be factored in. We see headline inflation crossing 10 percent next week and remaining around 9.5 percent in June and July,” said A. Prasanna, an economist at ICICI Securities in Mumbai.

“With this kind of inflation behaviour, we do not rule out further policy action in the July review.”

Indian federal bond yields jumped to their highest in six years after the inflation data, with the benchmark 10-year bond yield rising to 8.42 percent, its highest since May 2002. The stockmarket shed 0.4 percent on the day.

The inflation data showed a substantial jump from the previous week’s annual rise of 8.24 percent and a forecast of 8.28 percent in a Reuters poll of economists.

The inflation rate is now at its highest since Feb. 10, 2001, when it was 8.77 percent. Continuing a trend of sharp upward revisions, inflation for the week ended April 5 was revised up to 7.71 percent from a provisional 7.14 percent.

A Reuters poll carried out last week on the day fuel prices were raised showed economists expected the increases to lift inflation to a 13-year high of 9.2 percent in the 12 months to June 7, but forecasts are now being revised.

“With the fuel price pass-through we are staring at double-digit inflation. This is crazy,” said D.K. Joshi, principal economist at domestic ratings agency Crisil in Mumbai.

India’s inflation rate has more than doubled since late last year, driven higher by rising costs of raw materials and food.

FUELLING PRICE PRESSURES

Last Wednesday, the communist-backed ruling coalition, which faces state and general elections within the next 12 months, ended 10 days of debate over the political consequences and raised state-set petrol and diesel prices by about 10 percent.

The rise was bigger than expected as India joined a growing number of other Asian countries no longer able to afford big subsidies in the face of rising prices.

Energy costs account for 14.2 percent of the inflation index, and the price increases to key fuel inputs will have a cascading impact on overall prices in the economy.

Factory output rebounded in April from its slowest annual growth in six years, showing resilience which analysts said gave the RBI room to follow up on its decision to raise the key lending rate earlier this week.

“We may see more interest rate hikes given the rising inflation and the strong industrial production data,” Crisil’s Joshi said.

In three steps in April and May, the RBI raised the cash reserve ratio (CRR), the amount of funds banks have to keep on deposit with it, by 75 basis points to 8.25 percent, its highest level in seven years, to control cash in the system.

Economists said the CRR could be raised further, perhaps in tandem with rate increases.

“Given the RBI’s concern about anchoring inflation expectations, we expect another 25 basis point hike in repo rates during the third quarter of 2008 and another 100 basis points worth of cash reserve ratio hikes during this financial year,” said Sonal Varma of Lehman Brothers in Mumbai.

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